Get Ready for This: What the Global Real Estate Recovery Will Look Like in 2021 & Beyond

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Spencer Levy
I'm Spencer Levy and this is The Weekly Take. It's that time of year again when we analyze the developments and forces that have been shaping commercial real estate as it stands today, assess perspectives from around the world and consider the industry's future. On this episode, a deep dive into CBRE’s annual Midyear Outlook, which is hot off the presses this week, with two leaders of the worldwide team that created this impressive report.

Julie Whelan
The Midyear Outlook is a permanent fixture at CBRE research, and the reason is because the world is a rapidly changing place and we want our predictions to keep pace with that.

Spencer Levy
That's Julie Whelan, CBRE’s Global Head of Occupier Research, who returns the show from Boston.

Henry Chin
I think recovery is a lot stronger than what we originally thought in the beginning of the year.

Spencer Levy
And that's Henry Chin, CBRE’s Global Head of Investor Research. Henry joins us from across the Pacific in Taiwan's capital city, Taipei. The report that inspires our conversations is filled with insights and trends across sectors and asset classes and framed by the historic events of our times. In other words, there's a lot to talk about. Let's get right down to it. Coming up, CBRE’s 2021 Global Midyear Market Outlook. That's right now on The Weekly Take.

Welcome to The Weekly Take. Julie, before we get into the nuts and bolts of our 2021 midyear report, I think some of our listeners would like to know what went into making this report. Why don't you give us a little behind the scenes?

Julie Whelan
Absolutely, Spencer. So a lot goes into making this report and we have a lot of professionals around the globe that help provide us with the input to create what we have in the market today. And I would say the Midyear Outlook is a permanent fixture at CBRE Research. And the reason is because the world is a rapidly changing place and we want our predictions to keep pace with that. And so what our Midyear Outlook does is gives us a chance to give our readers a combined global point of view aligned with where our predictions are going. Now, the way that we do it is we have a team of researchers who are entrenched in their markets and they're entrenched with our CBRE professionals and our clients, and they are the engines and the heroes behind the outlook. And I would say the most difficult part of this is distilling all of their great insights into a piece that readers can digest quickly and easily and use it to make actionable decisions. But we hope that we have done that.

Spencer Levy
Well, Henry, what's your perspective? Are we basically on track with our predictions from where we were at the beginning of the year?

Henry Chin
Definitely. I think all our forecasts are pretty much aligned with what we are seeing across the markets. But when I was looking at a more quant numbers and looking at the investment volumes, looking at leasing volumes, I have to say U.S., Asia Pacific, both the leasing side and the transactional volume side, we are upgrading our forecast. So clearly, clearly, I think recovery is a lot stronger than what we originally thought in the beginning of the year. But I have to say, when I was looking at that news, looking at the pictures and what I was seeing, the Americans, the Europeans are starting having their holidays during the summer vacations, that definitely gives us this extra boost of confidence. The market's going to track back and of course, the delta variant is a big uncertainty for us right now.

Spencer Levy
Let's talk about where we are from an occupier perspective. I think leasing is a little bit behind where we thought it would be at this stage of the year. We're not seeing as much long-term leasing—though short-term leasing and flex space seems to be doing quite well. What do you think Julie?

Julie Whelan
The number one challenge that our tenants, that our clients, have been up against is not having strong occupancy in their office space. What that has led to is an inability for them to make long-term real estate decisions, which is why we have seen activity. But that activity has really been made up largely of renewals. It has been made up of short-term renewals and flex space—which you just had a podcast last week about Industrious—has actually come back stronger than ever. And what we would be hoping is that at the second half of 2021, we would start to see a more enhanced office occupancy, which would lead to longer term real estate decisions being made in the form of larger leases for longer term. Now, with this delta variant, we have a lot of occupiers who have most recently in the last couple of days made very public announcements, saying that they are going to delay their return to office for their employees. And those that are returning to the office, in many cases, need to remain mask wearing and remain socially distanced, which is going to make people not want to come into the office because they're not going to get the experience that they want. And so what this is going to do is further delay long-term leasing decisions because tenants just cannot understand what they're going to need in the long term, given the fact that they don't have observable trends today. But we do believe that transaction activity is picking up. We see it in the numbers, we see it in the sentiment, and we see it in tenants touring the market. And that's all positive at the end of the day.

Spencer Levy
Henry, what are the facts you're seeing on the ground not just in terms of occupancy, but to Julie's point, are we seeing more long-term leases in Asia?

Henry Chin
Yes, I think life seems to be very much back to normal in most of the Asia economies. And I think most of our staff across Asia are back to the offices. Given the recent Delta variance and that some governments are actually opposing restrictions on how many people you can be in the office—if you take that restriction away, I think pretty much 90 percent of the people are back to the office on the daily basis. In terms of the leases, when we were talking to our regional occupiers it's fascinating, particularly compared to the sentiment from last year. More than 50 percent of our occupiers across Asia Pacific are thinking about expanding their portfolios over the next two to three years. But they all trust the differences between the multinationals that the Western companies versus the Asian companies. I think the Asian companies … more than 66 percent of them say they want to expand in a bigger way. But because our leases they tend to be relatively short three years, we haven't seen much of a change in terms of the length of the dates.

Spencer Levy
Let's pause there and let's rewind the tape for a second there. You're suggesting to me that the average lease for an office tenant in Asia is about three years?

Henry Chin
Yes, that's only for three years. And so it's quite quick to renew. Australia is the other one. Australians tend to be five to 10 years. So we do see most of Australia major tenants and they are looking for flex options, flexible leases, as well as a flexible spaces. I think this is something which is a very, very different … Asia versus the Pacific.

Spencer Levy
Well, I'll tell you what, if I had a three year lease, I would consider that pretty flexible as an American with my average lease term of 10 to 15 years, sometimes longer. And I think this is a critical point for our listeners because a lot of our listeners are in the capital markets business and they hear the rise of flex space, the rise of shorter term leases, and they get concerned about value. They say, well, if they're shorter term leases, my building value is going to evaporate. But you're not seeing that in Asia at al. As a matter of fact, you're seeing values go up [and] cap rates compress. Is that not correct?

Henry Chin
That's correct. The beauty of a shorter lease is your renewal lease is going to be really reflective of the market conditions. If your market is on the rise, in recovery mode … actually it's more favorable for the investors. But as of now, I think clearly the market conditions are very favorable to the tenant side. Right? But we do expect once COVID is gone, we will see kind of with some markets moving to the positive momentum is going to change the dynamics very soon. So your asset value could be increased over the next two to three years.

Spencer Levy
I think the two lessons we're learning here among others from Asia is number one that short term leases can work and number two capital values can be maintained and maybe enhanced over the long term. So I wrote a piece earlier today that flex space and long-term leases aren't competitors, they're actually teammates now moving forward because of the want and the need for hybrid. But also it's not an enemy of the capital markets either. Julie, what's your perspective?

Julie Whelan
So I absolutely agree. We have been very bullish writing about the flexible office space for quite some time now. And I think that the best thing that could have happened for that subsector of space is to see the absolutely challenging environment that they've just gone through for the last 15 months. And the reason being is that there were a lot of skeptics of flexible office space in the form of a lot of capital markets participants that said, well, this is all well and fine during an up cycle. But when we do reach a place of a recession, it's going to fold and it's going to be a problem. And I think that what we have seen is the absolute opposite. We have seen very small amount of pullback from flexible office providers in the markets, and we have seen a extreme bounce back in this recovery time frame. And so to me, what that has created is, as Henry says, yes, shorter term leases allow for you to keep up with the market conditions as they roll in a much more real time basis. But also, when you think about the hedging that flexible office space can provide you, where you're actually able to rebound much more quickly for a portion of your office space, because we all know that typical traditional longer-term leases and the late lease activity actually lags the economic recovery by a number of quarters. And so being able to have flexible office space in your building and hedge that a little bit could actually be a positive in the long term. And we do see that more large occupiers are coming to the table wanting to have both long-term leases and short-term space agreements in the same building so that they can build a flexible portfolio while still having equity in terms of the experience that their staff has in the building.

Spencer Levy
Henry back to you on this one. Let me just ask you a very specific question. Where are cap rates today versus where they were pre-COVID?

Henry Chin
Actually we were expecting to see that cap rates move out in those CBD prime locations across Asia-Pacific metro markets … but actually about cap rates are trading as low as pre-COVID situation in some markets … even compress it further, particularly just the example of Korea. But we do feel like within Asia Pacific, some markets, offices, sectors, it does provide a nice countercyclical opportunity, such as Shanghai, such as Sydney. But not because investors don't want to put money into those two markets. It's largely because the imbalance of demand and the supply and we are seeing more and more investors returning back to the office markets is a simply because office is here to stay. Return to work is irrelevant for most part of Asia. And we are seeing the rent is creeping up. So the cap rates will probably stay lower for longer, potentially even compress further for those two major hubs.

Spencer Levy
OK, Julie, now, I was just listening to Henry's answer there. He's saying that Asia is back to normal and cap rates are now down at or below where they were pre-COVID. People are back in the office. Julie, I've been reading your research now for over a year on this, and we're talking about a significant falloff in demand. Doesn't the Asian situation give a good counterpoint to what our own models are suggesting in the United States?

Julie Whelan
Well, I think that this is a place where markets do differ. So I think that the lessons that we're learning in Asia Pacific, in some cases, we can apply to the U.S. and in other cases, I don't think that we can. I think that from a demand perspective, from an office standpoint, it's a very different story in the U.S. than it is in some of the Asia Pacific markets. We might be more similar to the Pacific than we are to Asia simply because of the culture around the office and being face to face and engaging in work at a physical workplace. Whereas here in the United States, I think that the pendulum is swinging a little bit further to a hybrid environment where people are going to share their time between the physical office and other places. And our best estimates is that that is going to equate to a 24 percent reduction of your time spent in the office for the average person. And so a lot of people jump to the conclusion that says, well, does that mean then 24 percent less demand for space? And our resounding answer is no. It is not a one-to-one ratio, simply because we have to solve for peak office demand. There is not going to be equal demand and occupancy in offices Monday through Friday. So we have to plan for that peak level. And also we want to design a different type of office space to meet the new type of worker that actually needs more space in some cases for collaboration zones and things like that. So our best guess is that we are probably going to have around a 9 percent space reduction per new worker added to the market. But we are also in a hot economic environment and all the job growth that's going to be added is going to equate to more office demand. And so our best guess is that in 2025, when we reach that full recovery that we hope we're going to see in the office market, that we are going to be back to the same occupancy levels in real estate that we were pre pandemic.

Henry Chin
You know, the average household sizes in Asia Pacific, in Hong Kong, its per capita per person. So 160 square footage. It’s tiny—160. So virtually impossible to be able to work from home. When I was talking to some occupiers in China—a multinational American one—last year, they want to bring people back to the office and they said, OK, I pay for your taxi fares, I pay for your breakfast, I offer free lunch. So incentivizing people to go back to the offices. And 12 months after, I was talking to the same group of people. I said, by the way guys, are you still having free lunch and free taxis? They said, no, the company has taken that away from them. And so that's just tells you that the sentiment that the face is a return to work is a very, very different.

Spencer Levy
Well, there's an expression in America there's no such thing as a free lunch. So let's now talk a little bit deeper about the midyear report, because if you dig into it, and I think part of the new office demand is not just based upon job growth, it's not just based upon the fact that we may have overestimated work from home … it’s based upon new industries, most notably life sciences. Henry, why don’t you tell us a little bit about that?

Henry Chin
I think the life sciences is a vast word and because of COVID, because of a vaccination adoption rates, because of a shortage of vaccines that globally, a lot of government is seeing life sciences as such a strategic industry. And so they want to give more. In my mind, life sciences actually have four different type of real estate. Number one is corporate offices, and they're followed by R&D labs and logistics and then talking about manufacturing facilities. And you can see—I’ll give you just the Asian numbers. Last year over overall in volume for offices was actually down by 25 percent. However, the life sciences, the take up was increased by 17 percent. This become one of the major, major drivers to underpin the officer demand. When I compare different regions, I think US is clearly leading ahead. I think in Asia we are only a third of the Americas’ R&D lab facilities and also for cold storages expense. If we want to catch up in cold storage facilities like the level in Asia, we need to build additional 410 million cubic meters of spaces. So that just tells you the life sciences is especially remote. It's not only for office. This is pretty much across all the different type of real estate.

Julie Whelan
Life sciences has certainly been one of the bright spots of the pandemic. I would say that here in the U.S. we track venture capital funding very closely when it comes to life sciences because venture capital funding and life sciences employment growth are hand in hand. Employment growth usually lags that VC funding by about 12 months. And so when you look at the VC funding that is coming into the market right now, it's at its highest levels ever. And so we can only assume that that employment growth and therefore that lab space demand is going to really continue to increase. And where is it going to continue to increase? Well I'm sitting here in Boston, Massachusetts, which has some of the best academic institutions and health care institutions around, and that's where these life sciences companies want to cluster and they want to grow because they get the talent that they need and the access to the innovation that they need through the interactions that they're all having in that ecosystem. And so these are the markets that we really believe are our growing markets like Boston, San Diego, San Francisco, some of the mid-Atlantic region. Even in, you know, Europe, there are some clusters forming in UK and Germany and France. And a lot of those biotech markets have funding that originates here in the U.S. from the companies that are in them, but they nonetheless are growing. So this is really a global equation. And there are other industries that are, you know, certainly growing. We have tech—and our tech talent report just came out—and tech talent has grown, you know, from their employment base. When we look at some of the largest deals that have been done in the market, they are tech deals. And so we are still very bullish on the driver of tech firms around leasing activity in the future. Real estate is still a very local equation. And understanding what industries are in each market and where their demand for space is coming from is really an important thing to remember and to understand.

Spencer Levy
We talked a little bit about the operational real estate, life sciences. We can talk about data centers, we can talk about cold storage. We know the hot asset classes, but industrial seems to be the gift that keeps on giving globally. What's your point of view on industrial, Henry?

Henry Chin
Well, I always have a very contrarian view in the industrial. Everyone love industrial logistic because it's a buzzword as well. And however, if I own the portfolios of one number for years, I’m probably at this point of time going to sell. I'm going to pocket the cash a real asset returns. The reason I say that is there are three megatrends that are coming from the occupiers. I think the occupiers are thinking about they want to diversify the source of the products. They want to close with the consumers. And they also want to improve the efficiencies. So when I was looking at the margins of all those 3PL companies, I have noticed those 3PL companies’ margin is so low and therefore they won't be able to pay the endless higher rent on the year-on-year basis. We got a supply is kicking into most of the markets. So therefore I do thinking about the logistic of rent, it probably is going to grow at a slower paces going forwards. So when we are talking to lots of occupiers—and funny enough particularly in Asia Pacific Coast—escalation has been one of the major hurdles for them to expand their portfolios. And that when I was talking to the other side to the investors, investors started showing some concerns after the entry cap because entry cap is pretty low. Is it quite unrealistic to underwrite the further corporate compressions? No, just they will continue to perform well, but only for two type of the assets. Supply chain cost 50 percent of all transportation related costs. So this is something it’s worth watching out for investors. Now, you really should look into build to suit them because they're tailor made for logistics. What the occupiers are looking for, everybody thinking about supply chains and no longer the issue. But I really want to highlight here supply chains still going to be a challenge for a lot of occupiers. If you look at the flooding in Germany, flooding in China, we may not have an iPhone deliver on Chinese time. And we also see that delta variant in parts of Southeast Asia and that they all potentially it's going to be a challenge for that spaces.

Spencer Levy
Well we're here talking about the 2021 Midyear Outlook. And while we're talking about the Midyear Outlook in industrial, I want to get into one other aspect of it, which is manufacturing. And Henry, what we're hearing a lot of here in the United States is what they're calling a plus one strategy, which is China is still going to be the manufacturing engine of the world for the indefinite future, but a plus one. What are you seeing about that in Asia?

Henry Chin
Yeah, definitely China plus one is quite prevail and quite evident in this part of the world. However, every nation’s fighting for what the plus one means. And that plus one in our terms is a VIP—and the V is the Vietnam, I it's Indonesia and P, it’s the Philippines. So those are three nations in Southeast Asia are competing on the VIP spaces and they're increasingly increasingly we are seeing India is popping up. I think India is enhancing the supply chain network, enhancing their manufacturing capacities, particularly related to life sciences as well. So therefore, I think India's on the rise. So definitely China plus one is a super important—even for us in Taiwan. Semiconductor, you know you need chips, and the other chips the majority of chips are producing in Taiwan. So we are also fighting that plus one here.

Spencer Levy
Well, Henry, since you brought up the VIP, I have to counter with the Big Mac—Mexico, America and Canada. And the reason why I'm going to counter with the Big Mac is because there are more people now talking about the world becoming more regionalized in the future because supply chains broke down. We didn't see the ability to bring in goods from China, the VIPs or otherwise. And maybe we will see more manufacturing coming back to the Big Mac, Mexico, America and Canada. Julie, do you have a point of view on that?

Julie Whelan
I think that supply chain disruption has certainly been an issue, right? We've had challenges with labor issues. There's been increased energy costs. There's been extreme weather patterns that are only going to continue as climate change we still get and try to get under control. When you look at what happened with the blockage of the Suez Canal, there has just been a lot of different factors at play that is creating, again, where I would also tend to be on Spencer's side on the argument of industrial, where we are going to have demand that also comes just from the need of an increase of safety stock that needs to be held on shore. And a lot of countries that will add a lot of demand for industrial and key real estate hubs. And so here in North America and South America, no doubt that regionalization is going to become really important so that we can help mitigate and combat all of these challenges, especially as e-commerce rises and we have more of a need for distribution around North America. So, yeah, I completely agree with that.

Spencer Levy
Let's talk now about hotels. We didn't talk much about it. But Henry, I want to go back to something you taught me maybe three or four months ago, that we're not just seeing pent up demand. We're seeing revenge retail. I think we're seeing revenge holidays now. People want to get out and spend money on hotels and they seem to be making a rapid comeback. Certainly the drive to staycation hotels. What do you see in Asia?

Henry Chin
I am so jealous of seeing you and Julie flying around to your summer holidays. We come off for summer holidays here simply because our borders are still largely closed. But nevertheless, investors are actually coming back to look at the hotels space. And if you ask any people across Asia Pacific, the number one destination people want to be after pandemic is Japan. As a result, more and more investors are looking at the hotel space as a tourist hotel spaces in Japan, in addition to some locations in Southeast Asia—Thailand, Indonesia. Those locations are definitely getting a lot more traction from the investors. Hotel operators are expecting the revenge of tourists and the hotels having a strong challenge last year. But now more and more people are holding more positive views into the hotel sector.

Spencer Levy
So let's now talk about some other macro issues here for just a moment. Inflation, interest rates—what are some of the other macro factors that you think are risks for our midyear forecast for the end of 2001 and moving into ‘22, Henry?

Henry Chin
I think the one thing we haven't seen much of on the macro factors is the government's willingness to support the economy, recovery stories in some part of the world. I think 2020 we navigate through quite OK. Is it largely because of all the government stepping up to provide the physical support? And the delta variant caught us by surprise. So we are going to watch it quite closely about our physical support from the government to support our employment, to support the economy growth engine. Now, one thing I think we have been talking a lot is if a lot of geopolitical tension will continue. And this is a very hard to forecast. But initially, I thought after the presidential election in the U.S. that we probably won't see much of the conflict between East and West. But it looked like that geopolitical disagreements, attention is going to lingering around for quite some time and that this is something we need to watch out for and that the final pause is more related to the U.S. I think also watching very closely with your government bond yield in the U.S., it was 1.6 percent there—it’s now down to 1.2 percent. So clearly, people does have a concern about the pace of the recovery. So it's something we need to be mindful.

Spencer Levy
Julie, let's come back to you now. I want to talk a little bit more about your outlook, not just for this year, but for the next couple of years, particularly with this labor shortage. With a labor shortage, doesn't that mean we are going to be even more concentrated in the major markets where labor is plentiful? Or do you think this trend that we've been seeing people moving to some of the smaller, as I call the new kids on the block, that Denver's, the Raleigh’s, the Columbus, Ohio's. You think that's going to continue or you think that's going to revert?

Julie Whelan
So I think that what we have seen in terms of migration trends is very akin to what we saw before the pandemic. It just accelerated a little bit. And so the question is, will those trends continue to accelerate or will they moderate back to a place where they were? I don't think that any of us believe that these trends are going to throw off any of the major markets like the primary gateway markets of New York and San Francisco and even Boston. But I think that a greater market share of talent is going to continue to flow into these secondary markets. Now, I took a look at the America's Investor Intention Survey before I came here, and I know that a lot of the large investors are actually preferring secondary markets today over primary markets in terms of their investment aspirations. And so I think that speaks a lot to where the demographic trends are going also because office is very durable in those markets right now because there's a lot of business growth supported by demographics and talent that are going to those markets. That does not mean I don't think that that's going to be at the expense of primary gateway markets. There just might be easier money to be had in those secondary markets.

Spencer Levy
ESG—environmental, social, governance. It has exploded in its importance in commercial real estate led by Europe. And I know Asia is also well ahead of the United States. What are you seeing there for investor preferences in ESG, Henry?

Henry Chin
Well, ESG is definitely a buzzword. I think the most challenging part is that the investment community is in the past is all looking at the numbers and the returns. But given the current climate changes while we are seeing in Germany, in China last week, I think more and more government paying extra attention to the ESG—particularly on the E front. And you can see in Japan by 2050, we have a net zero carbon emission to target and China is going to 2045. And even in Singapore, they want to raise the building for five meters above the sea levels going forward. So ESG is a really important element in this part of the world. I think most of our investors are talking about energy savings, waste management and that the water management as well. Increasingly, we are seeing more and more developers are looking at the green visas. So green visas is going to be so important in this part of the world. So ESG, we are just in the initial stages. We are looking at what Europe has been doing so. They will give us a great example is to speed up the process in Asia Pacific.

Spencer Levy
What is the office world look like two or three years from now versus today?

Julie Whelan
So two or three years from now, I believe that the office world is going to be in the height of transformation. So I think that there are a lot of lease expirations that are going to be coming due in 2023 timeframe as a result of the normal expiration cycle, plus all of the short-term renewals that have been done in the last year. And that's going to be the opportunity for tenants to really take a bite at the apple and make some serious transformational decisions about their portfolios. And so I think that in that time frame is when all of this thinking and speculation that we're putting to the future of office is really going to start to shine through. And we're really going to be able to see the realities of what that means for our office market.

Spencer Levy
Right, Henry same question to you in two or three years from now—looking back, what are we looking at in terms of commercial real estate in Asia versus today?

Henry Chin
I think Asia I do believe the structural changes will continue. All year we've been talking about life sciences, cold storages, e-commerce—the opportunity will continue to go forward. But I think two, three years’ time, you are thinking about what we should have done in 2021. Is it that I probably should put more money into the offices? I probably should have put more money into the retail because that was so good investment? I do believe that traditional office, retail as an asset class as is a good countercyclical play if we're thinking about and holding for the longer term. So that's my thought.

Spencer Levy
Awesome. Well, Julie I was going to ask you—that was your last question, but because Henry went out on a limb, he said buy office and retail, I'm going to say buy multifamily. I believe that is the best investment class for the next several years, certainly in America, because of the shortage of housing. What is your best investment advice for the next two to three years?

Julie Whelan
Best investment advice for the next two to three years is, I would say, buy secondary office, buy secondary office market.

Spencer Levy
And on behalf of The Weekly Take, I want to thank two of my very close colleagues, good friends, Julie Whalen, the Global Head of Occupier Research. Julie, thank you for joining us.

Julie Whelan
Thanks, Spencer.

Spencer Levy
And my good friend Henry Chin, who I've been working with now since 2014, rocked the house then you rocked the house today, Henry. Henry, thank you for joining us.

Henry Chin
Thank you, Spence.

Spencer Levy
Thanks to Julie and Henry, as well as to the global research team at CBRE for the substantial work that we just discussed. And thank you for tuning in. If you'd like to read the complete 2021 Global Midyear Market Outlook, you can download the report at CBRE.com/GlobalOutook. And if you'd like to find out more about our guests or show, check out our website, CBRE.com/TheWeeklyTake. The outlook for our podcast, of course, is terrific. We’re already at work on some fascinating new episodes, including conversations on hybrid work, innovation in the solar power industry and more economic thought leadership and more. So come on back for insights on those topics. In the meantime, share the show and please subscribe, rate and review us wherever you listen. Thanks again for joining us. I'm Spencer Levy. Be smart, be safe, be well.